David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Tootsie Roll Industries, Inc. (NYSE:TR) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Tootsie Roll Industries's Debt?
The chart below, which you can click on for greater detail, shows that Tootsie Roll Industries had US$8.49m in debt in June 2021; about the same as the year before. However, its balance sheet shows it holds US$139.2m in cash, so it actually has US$130.7m net cash.
How Healthy Is Tootsie Roll Industries' Balance Sheet?
According to the last reported balance sheet, Tootsie Roll Industries had liabilities of US$75.6m due within 12 months, and liabilities of US$166.8m due beyond 12 months. Offsetting these obligations, it had cash of US$139.2m as well as receivables valued at US$38.3m due within 12 months. So it has liabilities totalling US$64.9m more than its cash and near-term receivables, combined.
Since publicly traded Tootsie Roll Industries shares are worth a total of US$2.15b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Tootsie Roll Industries also has more cash than debt, so we're pretty confident it can manage its debt safely.
On the other hand, Tootsie Roll Industries saw its EBIT drop by 3.2% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Tootsie Roll Industries will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Tootsie Roll Industries may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Tootsie Roll Industries generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
We could understand if investors are concerned about Tootsie Roll Industries's liabilities, but we can be reassured by the fact it has has net cash of US$130.7m. The cherry on top was that in converted 93% of that EBIT to free cash flow, bringing in US$51m. So we don't think Tootsie Roll Industries's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Tootsie Roll Industries has 2 warning signs (and 1 which can't be ignored) we think you should know about.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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